2024 – Speedy Delivery Systems can buy a piece of equipment that should provide an 6 percent return and can

Speedy Delivery Systems can buy a piece of equipment that should provide an 6 percent return and can be financed at 3 percent with debt. The CEO likes earning more than the cost of debt, and he thinks this would be a good deal. The firm can also buy a machine that would yield a 14 percent return but would cost 16 percent to finance through common equity. Earning less than the cost of equity sounds bad to the CEO. Assume debt and common equity each represent 50 percent of the firm’s capital structure.

(a)

Compute the weighted average cost of capital. (Round your intermediate and final answers to 1 decimal place. Omit the “%” sign in your response.)

  Weighted average cost of capital

[removed]%  

(b)

Which project(s) should be accepted?

-United Business Forms’ capital structure is as follows:

  Debt

35

%

  Preferred stock

30

  Common equity

35

The aftertax cost of debt is 10 percent, the cost of preferred stock is 13 percent, and the cost of common equity (in the form of retained earnings) is 16 percent.

Calculate United Business Forms’ weighted cost of each source of capital and the weighted average cost of capital. (Round your answers to 2 decimal places. Omit the “%” sign in your response.)

Weighted cost

  Debt (K_d)

[removed]

%  

  Preferred stock (K_p)

[removed]

  Common equity (K_e)

[removed]

  Weighted average cost of capital (K_a)

[removed]

%  

-Assume a $260,000 investment and the following cash flows for two products:

Year

Product X

Product Y

1

$

90,000

$

80,000

2

80,000

70,000

3

80,000

50,000

4

40,000

80,000

(a)

Calculate the payback for products X and Y. (Round your answers to 2 decimal places.)

Payback period

  Product X

[removed]

 years

  Product Y

[removed]

 years

(b)

Which alternative would you select under the payback method?

-Hamilton Control Systems will invest $99,000 in a temporary project that will generate the following cash inflows for the next three years. Use Appendix B.

Year

Cash flow

1

$

37,000

2

34,000

3

95,000

The firm will also be required to spend $18,000 to close down the project at the end of the three years.

(a)

Compute the net present value if the cost of capital is 11 percent. (Round “PV Factor” to 3 decimal places. Round your answer to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

  Net present value

$ [removed] 

(b)

Should the investment be undertaken?

-Diaz Camera Company is considering two investments, both of which cost  $30,000. The cash flows are as follows:

Use Appendix B.

Year

Project A

Project B

1

$

15,000

$

14,000

2

15,000

14,000

3

6,000

11,000

(a-1)

Calculate the payback period for project A and project B. (Round your answers to 2 decimal places.)

Payback period     

  Project A

[removed]years  

  Project B

[removed]years  

(a-2)

Which of the two projects should be chosen based on the payback method?

(b-1)

Calculate the net present value for project A and project B. Assume a cost of capital of 8 percent. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Omit the “$” sign in your response.)

Net present value

  Project A

$ [removed]     

  Project B

$ [removed]     

(b-2)

Which of the two projects should be chosen based on the net present value method?

  (c)

Should a firm normally have more confidence in answer derived based on Net present value method or Payback method?

-King’s Department Store is contemplating the purchase of a new machine at a cost of $28,552. The machine will provide $4,600 per year in cash flow for 11 years. King’s has a cost of capital of 9 percent. Use Appendix D.

(a)

What is the internal rate of return? (Round “PV Factor” to 3 decimal places. Round your answer to the nearest whole percent. Omit the “%” sign in your response.)

  Internal rate of return

[removed]%  

(b)

Should the project be undertaken?

–Wildcat Oil Company was set up to take large risks and is willing to take the greatest risk possible. Richmond Construction Company is more typical of the average corporation and is risk-averse.

Projects

Returns:
Expected value

Standard
deviation

A

$

320,000

$

149,000

B

693,000

435,000

C

187,000

152,000

D

145,000

234,000

(a-1)

Compute the coefficients of variation. (Round your answers to3decimal places.)

Coefficient of
variation

  Project A

[removed] 

  Project B

[removed] 

  Project C

[removed] 

  Project D

  [removed]  

(a-2)

Which of the following four projects should Wildcat Oil Company choose?

(b) 

Which one of the four projects should Richmond Construction Company choose based on the same criteria of using the coefficient of variation?